Revenue recognition among proposals released as FASB, IASB commit to new timeline.

FASB
and the IASB wrapped up the first of three rounds of issuing
proposed standards in their final push toward U.S. GAAP-IFRS
convergence, even as they gave themselves an extra six months to
complete the ambitious project.

In
what is potentially their most far-reaching joint proposal to date,
the boards unanimously recommended an approach to revenue
recognition that would create one standard across all industries and
would require greater disclosures, among other changes.

The
revenue recognition proposal came a month after FASB issued its own
proposal on accounting for financial instruments. The two boards are
currently pursuing their own approaches to financial instruments but
have pledged to try to reconcile this fall.

The
boards consider revenue recognition, financial instruments and two
projects closely related to financial instruments—fair value
measurement and the presentation of other comprehensive income—to be
urgent projects in the larger IFRS-U.S. GAAP convergence effort, and
they said they remain committed to completing them by their
self-imposed June 2011 deadline. Other priority projects scheduled
for June include insurance contracts, leases, consolidations and
derecognition. But the boards extended their deadline to December
2011 for less-urgent projects on financial statement presentation
and financial instruments with characteristics of equity.

REVENUE RECOGNITION

The
proposed revenue recognition standard, released June 24, is designed
to streamline accounting for revenue across industries and correct
inconsistencies in existing standards and practices.

“I
think it will make accountants’ jobs easier when new types of
business arrangements emerge because they’ll have one standard to
look to on how to recognize revenue for the arrangement,” FASB board
member Leslie Seidman said in a podcast outlining the proposed
changes. In the U.S., revenue issues have been dealt with on an ad
hoc basis over the years, creating a “very complex, inconsistent and
incomplete set of standards,” Seidman said. Meanwhile IFRS offers
very little guidance on revenue recognition.

The
joint standard “would make it absolutely clear when revenue is
recognized—and why,” IASB Chairman Sir David Tweedie said in a news release.

The
core principle of the 170-page exposure draft “is that a company
should recognize revenue when it transfers goods or services to a
customer in the amount of consideration the company expects to
receive from the customer,” according to an overview released by the boards.

In
the overview, FASB points to four differences between current
practice and the proposal. The first is that revenue would be
recognized only from the transfer of goods or services to a
customer. That change would affect some long-term contracts, the
standard setters said. For example, percentage-of-completion revenue
recognition would be allowed but only if the customer owns the
work-in-progress as it is built or developed.

In
addition, a company would be required to account for all distinct
goods or services, which could require it to separate a contract
into different units of accounting from those identified in current
practice. Another change would be that collectability would affect
how much revenue is recognized, rather than whether revenue is
recognized. And greater use of estimates would be required in
determining both the amount to allocate and the basis for that
allocation, which would better reflect the economics of a transaction.

FASB
also created a chart showing the five steps a company would follow
to apply the new revenue recognition proposals (see Exhibit 1).

The
proposal would be applied to all contracts to provide goods or
services to customers, except leases, insurance contracts, certain
contractual rights and obligations, guarantees (other than product
warranties) and certain nonmonetary exchanges. Companies would be
required under the standard to disclose qualitative and quantitative
information about contracts with customers, including a maturity
analysis for contracts extending beyond a year, and the significant
judgments and changes in judgments made in applying the proposed
standard to those contracts.

The
effective date for the potential changes has not been set. The
deadline for comments on the proposal is Oct. 22. The final standard
is expected in the second quarter of 2011 if the boards are able to
respond to feedback received through comment letters, round-table
meetings and other outreach, Seidman said in her June podcast. She
noted in the podcast that the proposal has unanimous support from
both boards.

“That
is a far cry from where we were a couple years ago on this project,
where we really did have very divided views on the basic proposal,”
Seidman said. “But we were able to work through those and come to a
proposal where we’re all on board.”

NEW
CONVERGENCE TIMELINE

Also
on June 24, a day ahead of the G-20 Summit in Toronto, FASB and the
IASB released a joint progress report and revised work plan that
extended by six months their June 2011 deadline for completing
convergence projects.

Last
September the leaders of the G-20 called on “international
accounting bodies to redouble their efforts to achieve a single set
of high quality, global accounting standards within the context of
their independent standard setting process, and complete their
convergence project by June 2011.”

In a
letter to the G-20, the boards explained that additional time was
requested by stakeholders to deal with the volume of proposed
changes and emphasized a shared commitment to improving IFRS and
U.S. GAAP and achieving their convergence.

“We
are limiting to four the number of significant or complex exposure
drafts issued in any one quarter,” the progress report said. “This
change is intended to address stakeholder concerns about their
capacity to respond. It also reduces the number of major proposals
we are re-deliberating at the same time, improving our ability to
focus on the input received and reconcile differences in views in
ways that produce improved and more internationally comparable
financial reporting.”

The
modified convergence timeline keeps the June 2011 target end date
for projects that have the “most urgent” needs, according to the
joint report. “Projects we believe are a relatively lower priority
or for which further research and analysis is necessary are now
targeted for completion after the original June 2011 target date,”
the boards said.

The
new schedule features three rounds of exposure drafts with revenue
recognition, financial instruments, the reporting of comprehensive
income and fair value measurement comprising the now-completed first
round (see Exhibit 2).

FINANCIAL INSTRUMENTS

FASB
launched the first round of convergence EDs on May 26 when it issued
a much anticipated exposure draft intended to improve accounting for
financial instruments (see Exhibit
3). The FASB financial instruments ED was issued
separately from the IASB’s proposals, which contain significant differences.

Among
other changes under the proposed Accounting Standards Update (ASU),
financial statements would incorporate both amortized cost and fair
value information about financial instruments held for collection or
payment of cash flows (see Exhibit 4).

The
proposal also aims at providing more timely information on
anticipated credit losses to financial statement users by removing
the “probable” threshold for recognizing credit losses. It seeks to
better portray the results of asset-liability management activities
at financial institutions.

FASB
said other potential improvements addressed by its proposed ASU,
Accounting for Financial Instruments and Revisions to the
Accounting for Derivative Instruments and Hedging
Activities—Financial Instruments (Topic 825) and
Derivatives and Hedging (Topic 815), include a single credit
impairment model for both loans and debt securities and simplified
criteria for hedge accounting.

“Today,
there also is arguably too high a threshold before an entity is
required to record credit impairments resulting in a delayed
recognition of losses, while complex hedging requirements produce
reported results that lack transparency and consistency,” FASB said
in a briefing document accompanying the ASU’s release.

FASB
also noted that the impact the proposals would have on a given
entity would depend on how great an extent financial instruments
play in the entity’s operations and financial position. “For
example, a large bank that presents a large number of financial
assets at amortized cost will be the most affected,” the briefing
paper said. “Non-banks likely will be least impacted.”

FASB
is projecting that the new rules would take effect no earlier than
2013. To minimize the impact of the changes on smaller and community
banks, nonpublic entities with less than $1 billion in total
consolidated assets would be allowed a four-year deferral beyond the
effective date from certain requirements relating to loans and core
deposits. This deferral would apply to nearly 90% of all U.S. banks
that hold just 10% of the country’s financial assets, FASB said.
Also, some financial instruments, including pension obligations and
leases, are entirely exempt, FASB said.

In
December, the AICPA’s Accounting Standards Executive Committee
(AcSEC), now known as the Financial Reporting Executive Committee
(FinREC), weighed in on FASB’s discussion of when fair value should
be used to measure and record financial instruments on the balance sheet.

In a
letter, FinREC Chairman Jay Hanson said the committee favors an
approach that would measure many but not all financial instruments
on the balance sheet at fair value.

FinREC
said in the letter that “a one-size-fits-all balance sheet
measurement approach for financial instruments will not result in
useful information across all user categories (for example, equity
analysts, private company lenders, credit rating agencies, sureties,
venture capital investors, and donors to [not-for-profit entities.]”

FinREC
“believes that the nature of a financial instrument, along with its
established use in an entity’s business model, should impact the
determination of whether that instrument should be measured and
recorded on the balance sheet at fair value,” the letter states. “In
addition, [FinREC] believes that the needs of the primary financial
statement users, which may vary by the type of entity (meaning
public company, private company, or not-for-profit organization),
should be an important factor in determining the most meaningful
measurement of financial instruments.”

The
committee cited a 30-year fixed-rate mortgage loan held to maturity
as an example of a financial instrument that should not be measured
and recorded on the balance sheet at fair value. The committee
suggested FASB should perform a user needs assessment as it moves forward.

Following
the Sept. 30 comment deadline, FASB says it plans to hold public
round-table meetings during October to collect additional input.

STATEMENT
OF COMPREHENSIVE INCOME AND FAIR VALUE MEASUREMENT

On
the same day it issued its proposed ASU on financial instruments,
FASB also issued for public comment a separate, but related,
proposed ASU, Comprehensive Income (Topic 220): Statement of
Comprehensive Income, that would require total comprehensive
income and its components in two parts—net income and other
comprehensive income—be displayed in a continuous statement of
financial performance.

On
June 29 the boards issued separate EDs on fair value measurements.
Under the EDs, U.S. GAAP and IFRS measurement and disclosure
requirements would be the same except for minor differences in
wording and style, the boards said.

The
most significant amendments in FASB’s ED focus on subsequent
measurement and disclosures. Under the ED, ASC 820-10-35,
Subsequent Measurement, would:

Reflect
that the highest and best use and valuation premise concepts are
only relevant for nonfinancial assets;

Add
guidance for measuring financial assets and financial
liabilities when a reporting entity has offsetting positions in
market risks or counterparty credit risk;

Add
guidance for measuring an instrument classified in a reporting
entity’s stockholders’ equity; and

Be
amended related to the application of blockage factors and other
premiums and discounts in a fair value measurement.

ASC
820-10-50, Disclosure, would:

Be
amended related to disclosure requirements for recurring and
nonrecurring measurements;

Disclose
uncertainty analysis for measurements categorized within Level 3
of the fair value hierarchy; and

Disclose
when a reporting entity uses an asset in a way that differs from
the asset’s highest and best use when that asset is recognized
at fair value in the balance sheet on the basis of its highest
and best use.

DIFFERENCES
ON FINANCIAL INSTRUMENTS

Unlike
the situation with revenue recognition, FASB and the IASB are not in
agreement on financial instruments. In a move that was not followed
by FASB, the IASB split its project to replace IAS 39, Financial
Instruments: Recognition and Measurement, into three parts to
deal separately with classification and measurement; impairment; and
hedging. FASB decided to deal with all three aspects of financial
instruments in a single project.

FASB
and the IASB have been unable to agree on a common approach for
classification and measurement. The IASB published its approach on
Nov. 12, 2009, with the release of IFRS 9, Financial
Instruments. IFRS 9 may be adopted early but is not effective
until Jan. 1, 2013.

But
both boards are asking for comments on both approaches and pledge to
work through the differences this fall.

Tweedie,
the IASB chairman, said in a JofA interview that the
divergent approaches were caused by mismatched timing between the
boards’ work and the inherent problem of having two major standard
setters rather than one. The key, according to Tweedie, is that
“both of us are asking the others’ constituents to look at the
opposite model. So this fall, we can say the world in balance thinks
this is the best approach.”

FASB
spokesman Neal McGarity expressed similar sentiments. “Although our
approach in the AFI proposal is different than that of the IASB’s,
we share the same goal of reaching a converged set of answers,” said
McGarity. “When the feedback from both boards are collected and
shared, we will work together with the IASB to come up with
converged answers for financial instruments later in the year.”

EXECUTIVE SUMMARY

FASB
and the IASB have completed the first of three expected rounds
of releasing exposure drafts in
their effort to converge U.S. GAAP and IFRS.

The
boards released a revised work plan that extended by six months
their self-imposed June 2011 deadline for completing convergence
projects. The
new plan limits to four the number of significant or complex
exposure drafts issued in any one quarter, with revenue
recognition, financial instruments, the reporting of other
comprehensive income and fair value measurement comprising the
first round.

The
joint revenue recognition proposal is built around the principle that a
company should recognize revenue when it transfers goods or
services to a customer in the amount of consideration the company
expects to receive from the customer.

Under
the proposal, a company would be required to account for all
distinct goods or services, which
could require it to separate a contract into different units of
accounting from those identified in current practice. And
collectability would affect how much revenue is recognized, rather
than whether revenue is recognized.

FASB
separately issued an exposure draft intended to improve
accounting for financial instruments. The
IASB, which is releasing its own set of proposals on financial
instruments, asked its constituents to comment on the FASB plan.
The boards plan to jointly consider the comments received on both
models.

Under
the FASB proposal, financial statements would incorporate both
amortized cost and fair value information about
financial instruments held for collection or payment of cash
flows. It also aims at providing more timely information on
anticipated credit losses to financial statement
users.